Did the Fed Cause the Commodity Bubble?

I spent an inordinate amount of time back in 2010 & 2011 talking about the potential for a commodity bubble that was Fed induced (see here, here and here). It’s now clear that the commodity collapse is rippling through many financial markets and it’s only a matter of time before the blame game starts here. I figured I’d go ahead and start pointing fingers before we even have a real crisis on our hands.

The three big players in the commodity boom were clearly China, Wall Street and the Fed. Some might wonder what the transmission mechanism from the Fed to the commodity markets is, but it’s well documented that negative real rates tend to coincide with higher demand for commodities. I also documented the impact of QE in real-time. There were numerous confirmed reports of commodities traders hoarding inventory in anticipation of higher prices following QE. After all, the whole point of QE is to create a market distorting impact where we drive investors out of certain assets and into others (the Fed can’t control where that extra demand gets diverted). It’s only natural that, on the back of those (flawed) hyperinflationary beliefs that persisted, that we’d see a surge in real asset demand.

The Wall Street transmission mechanism was through the financialization of commodities as commodities became an increasingly popular asset class. Regulars will know that I have not been a big fan of this idea that commodities are an “investment”, but Wall Street has recently constructed the idea that commodities are an asset class just like stocks and bonds. This can’t be true though since commodities are little more than a cost input in the capital structure. The fact that they don’t produce real long-term returns shouldn’t be surprising since, by definition, they must correlate with the rate of inflation.

The last major cause was clearly China. China essentially tried to corner the commodity markets as they built out their ever growing list of empty cities in some delusional version of “if you build it, they will come”. And now that they didn’t come the demand for commodities from China has cratered.

I’ve been pretty hard on the Fed and the various iterations of QE over the years. And I think that’s been largely right. In essence, I view QE as a simple asset swap that has no significant impact on the real economy, but can significantly distort markets. But the Fed hasn’t been alone in this journey. They’ve gotten a lot of help along the way. And if we have to place blame on one major player I think it’s probably safe to place that blame largely on China and what looks like the collapse of their state run version of “Capitalism”. So, the Fed doesn’t get all the credit here though it’s not for lack of trying.